Stephen Bainbridge's Journal of Law, Politics, and Culture

07/26/2011

The distinction between uncertainty and risk: A West Point perspective

Risk and uncertainty, of course, are bedrock principles/problems of business and business law. I just read an interesting paper on the distinction between the two, which fortunately is free at the moment at the Journal of Applied Corporate Finance but soon will be buried behind the Journal's paywall. Here's the abstract:

In this edited transcript of a presentation at the CARE/CEASA conference, a U.S. army officer who teaches economics and finance at West Point discusses the Army's approach to managing uncertainty and risk while reflecting on his own two tours of duty in Iraq. The U.S. military makes a clear distinction between risk and uncertainty. Whereas “risks” are threats to a mission or operation that can be identified, and at least to some degree controlled or mitigated, “uncertainty” applies to unknown or ambiguous hazards that resist any application of probability theory or quantitative methods. The risk mitigation process begins with assessments of the probability and severity of a given risk followed by the development of controls designed to limit that risk. Once the controls are implemented, the process becomes a continuous feedback loop in which the controls are evaluated and, if ineffective, either adjusted or eliminated. The Army has two main ways that it tries to mitigate uncertainty: the “information‐focused” solution and the “action‐focused” solution. The information‐focused solution aims to reduce uncertainty by getting better information, and processing and disseminating it more quickly than the enemy. It also aims to avoid the illusion of precision that can come from too detailed predictions and instead plans for a worst‐case scenario as well as a most‐likely scenario. The action‐focused solution acknowledges that, no matter how good your information, some uncertainty is unavoidable, and the aim of this part of the program is to develop, train, and maintain units that can fight and win in the face of uncertainty. Much of this capability is attributed to training and a mission command framework in which intensive strategic planning (involving “the who, what, when, where and why of an undertaking”) and communication of the plan to field commanders and subordinate leaders is combined with heavy emphasis on the exercise of initiative by those field commanders and leaders.

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The distinction between uncertainty and risk: A West Point perspective

Risk and uncertainty, of course, are bedrock principles/problems of business and business law. I just read an interesting paper on the distinction between the two, which fortunately is free at the moment at the Journal of Applied Corporate Finance but soon will be buried behind the Journal's paywall. Here's the abstract:

In this edited transcript of a presentation at the CARE/CEASA conference, a U.S. army officer who teaches economics and finance at West Point discusses the Army's approach to managing uncertainty and risk while reflecting on his own two tours of duty in Iraq. The U.S. military makes a clear distinction between risk and uncertainty. Whereas “risks” are threats to a mission or operation that can be identified, and at least to some degree controlled or mitigated, “uncertainty” applies to unknown or ambiguous hazards that resist any application of probability theory or quantitative methods. The risk mitigation process begins with assessments of the probability and severity of a given risk followed by the development of controls designed to limit that risk. Once the controls are implemented, the process becomes a continuous feedback loop in which the controls are evaluated and, if ineffective, either adjusted or eliminated. The Army has two main ways that it tries to mitigate uncertainty: the “information‐focused” solution and the “action‐focused” solution. The information‐focused solution aims to reduce uncertainty by getting better information, and processing and disseminating it more quickly than the enemy. It also aims to avoid the illusion of precision that can come from too detailed predictions and instead plans for a worst‐case scenario as well as a most‐likely scenario. The action‐focused solution acknowledges that, no matter how good your information, some uncertainty is unavoidable, and the aim of this part of the program is to develop, train, and maintain units that can fight and win in the face of uncertainty. Much of this capability is attributed to training and a mission command framework in which intensive strategic planning (involving “the who, what, when, where and why of an undertaking”) and communication of the plan to field commanders and subordinate leaders is combined with heavy emphasis on the exercise of initiative by those field commanders and leaders.